Month: June 2018

Preface: This blog is for entrepreneurs who are hereby advised to apply appropriate tax planning for their businesses activities to optimize the tax benefits and nuances of the new Section 199A tax laws, beginning with the 2018 tax year.

A Summary of the New Tax Laws For Section 199A

Tax Implications and Planning Features with the Qualified Business Income Deductions

Credit: Donald J. Sauder, CPA, CVA

Minted the Tax Cuts and Jobs Act, the newest business tax legislation relevant to the 2018 tax year, appears to have unique tax characteristics that are intentionally vague for taxpayers with regards to certain IRS code section interpretations. The summarized IRS tax code relevantly exemplified specifically to this blog are for the Section 199A or the Qualified Business Income Deduction.

To be confidentially advised towards IRS audit proof tax planning decisions for the 2018 tax year, it is imperative to understand how the new tax law of Section 199A are applicable to certain qualifying entrepreneurial activities and corresponding tax positions e.g. tax laws for service and non-service businesses, exact definitions of qualified business income (QBI) and individual tax filing threshold limits on Section 199A.

The new Section 199A tax code permits individual tax filers to deduct as much as 20% of qualifying 199A income for tax filing purposes beginning with the 2018 tax year. The qualifying Section 199A income includes qualified business income (QBI) from say partnerships, sole proprietorships, or S-Corporation. As with most new tax laws, Section 199A section has numerous tax planning nuances that we will outline in the following paragraphs.

A Section 199A Outline

So, what is Section 199A? It is a tax deduction akin to the prior Domestic Production Activity Deduction under Section 199. With the unique modifications to Section 199A (Section 199 called DPAD in prior years, was capped at 9% of qualifying income or 50% of W-2 wages), for the current tax year, business tax planning will encompass an entirely new level of tax variables with the introduction of this tax law modification.

The Section 199A deduction begins with the tax year 2018 and is currently legislated now, until 2025. Firstly, Section 199A is a standard 20% deduction of QBI from unadjusted income, with a threshold limit on individual taxpayer earnings, e.g. exceeding $315,000 MFJ or $157,500 otherwise. The Section 199A deduction limit phases out over $415,000 MFJ or $207,500 filing otherwise. Above these individual filing threshold’s, the Section 199A is limited to 1) the greater of the 50% of timely filed W-2 business wages, or 2) the combined sum of 25% of W-2 wages plus 2.5% of unadjusted qualifying business property.

The obviously unique characteristics of Section 199A from prior Section 199 DPAD also include capital gains, say from sales of stocks or bonds, being entirely deducted from QBI as non-qualifying income, and permitting a potential deduction for businesses that have zero W-2 income yet substantial unadjusted basis in property, i.e. in-service fixed assets.

Here’s how Section 199A works. If your taxable income is less than $315,000 MFJ or below $157,500 filing single, you receive a standard 20% Section 199A deduction from taxable income. Below the threshold level the Section 199A is a standard applicable 20% deduction for both service and non-service businesses, e.g. all entrepreneurs can supposedly participate in the tax benefits below that threshold.

Example: Bob and Brenda are married filing jointly. Brenda has QBI from a non-service business of $30,000. Their joint income is $375,000 for the tax year. Brenda receives a wage allocation of $40,000 from the business. The 50% of W-2 wages is $20,000. The $20,000 of wages are reduced from the $30,000 of QBI by the $60,000/$100,000 or 60% (excess of income from $315,000 threshold) equaling $12,000. So, the Section 199A is the $30,000 QBI subtracting the $6,000 threshold limit, equaling $2,400 of Section 199A tax benefits. Interesting math say?

End of Segment I — to be continued.

Preface: “God never made a promise that was too good to be true” – D.L. Moody.  The Pennsylvania EITC is good and it is true, and gives Pennsylvania taxpaying constituents and parents of children in private K-12 grade school, something to smile about today.

Too Good to Be True: Funding Education with Tax Dollars?

Credit: Jacob Dietz, CPA

The Congress and the President handed the American people tax reform. Tax reform has various benefits that could make you smile, but it also has some reductions in certain tax benefits, such as the SALT (State And Local Tax, it has nothing to do with table salt) deduction cap.

SALT Cap

The SALT deduction has been capped at $10,000 starting with 2018, although the standard deduction has been increased for taxpayers that choose not to itemize. This new cap prevents a taxpayer from deducting more than $10,000 for their real estate taxes, state income tax, and local income tax as part of the taxpayer’s itemized deductions. Please note that this new rule does NOT limit the real estate taxes that can be deducted for real estate rentals or as part of a business. For some taxpayers, this cap will affect their bottom line.

For example, assume Melvin paid $8,000 in real estate taxes, $4,500 in PA income taxes, and $2,000 for local taxes. Under the old tax rules, Melvin’s SALT deduction would have been $14,500 if he itemized his deductions. Tax reform caps Melvin’s SALT is deduction at $10,000. Melvin therefore pays $4,500 of PA income taxes but he receives no increased deduction for it.

Is There a Solution?

Is there anything Melvin can do? Melvin could reduce his PA taxes if his business received the Pennsylvania Educational Improvement Tax Credit (PA EITC) by contributing to a qualified institution. The PA EITC is a tax credit against various PA taxes on eligible donations to qualifying organizations. If you want more details on the PA EITC, click here to read this blog.

Assume like Robert Louis Stevenson said, “Children are certainly too good to be true” and Melvin’s grandchildren attend a Christian school, and he endorses their education already, personally donating funds to the school. Melvin also owns and operates a single member limited liability company (SMLLC.) Instead of donating personally, Melvin could apply for the PA EITC for donations made to the school through his SMLLC. If approved, he could get a 90% Pennsylvania tax credit for his contributions with a 2-year commitment to contribute.

Let’s put some numbers to the scenario. Melvin’s SMLLC filed for and received approval for a 90% credit ($4,500) for a $5,000 contribution for two consecutive years. The company therefore pays $5,000, and the majority of that $5,000 makes it to his grandchildren’s school (a fee goes to administrative costs if he pays via a conduit scholarship fund say.) Pennsylvania gives his single-member LLC business a $4,500 (90% of $5,000) credit for the contribution, which he can pass down to use on his personal tax return.

Melvin avoids paying the $4,500 of PA taxes that would have been nondeductible under the new tax reform, and he contributed to education at the same time. Since he owes no state income tax, then the total remaining taxes of $10,000 ($8,000 real estate taxes and $2,000 local taxes) are not limited by the $10,000 cap. Melvin therefore used his money to build the Kingdom while still complying with the government’s rules.

Reason to Smile

If the tax reform SALT cap caused you to frown, and if you live in Pennsylvania, consider if the PA EITC is right for you. The PA EITC gives taxpayers and parents of children in school something to smile about.

Preface: Do you own a house whose value has increased since you bought it? If so, you might be curious about the tax consequences if you sell it. The taxes for selling a house vary depending on the scenario. This article explores some of the tax consequences when selling houses.

Tax Planning on Residential Real Estate Transactions (Segment II)

Credit: Jacob M. Dietz, CPA

Business of Buying and Selling

For this scenario, assume the profitability of buying and selling houses impressed John so much that he decided to quit his construction job to buy and sell houses full-time. He started buying houses, fixing them up himself, and then selling them at a profit. John managed to sell a house about every 2 months. In this scenario, John operates a business. The profits therefore would not be capital gains even if he managed to hold onto a property for more than a year. Furthermore, if John does not have an approved Form 4029 exempting him from self-employment tax, then John would owe self-employment tax on the earnings from his house-flipping business.

Since it is a business, John should carefully track expenses associated with it. Levi asked John to track which expenditures add basis to the property and which can be deducted immediately. Levi explained that certain fees paid when purchasing should be added to the basis, such as recording fees and transfer taxes. Construction costs to improve the house, such as adding a bathroom or a new retaining wall, should also be added to the basis. When John sells the property, the basis will then be subtracted from the sales price, reducing John’s income.   John and Levi should also consider if there are any filing requirements for his business, such as 1099s.

“One such advantage is the Section 199A Qualified Business Income Deduction. This taxpayer-friendly part of the tax system allows John to deduct up to 20% of net income from his house-flipping business, subject to certain restrictions”.

Although there is a higher tax rate if he is in the business of flipping houses instead of investing in properties for more than a year, there are also some advantages. One such advantage is the Section 199A Qualified Business Income Deduction. This taxpayer-friendly part of the tax system allows John to deduct up to 20% of net income from his house-flipping business, subject to certain restrictions.

Buy and Use as Principal Residence

Let’s change up the first scenario. Suppose John buys the brick rancher for 200,000, and he really likes the house. He likes it so much that he moves in after marrying Rose, and they live there for 3 years. When John and Rose sell the house 3 years and 1 month after purchase, they sell it at a spectacular $100,000 gain. Before selling, John called Levi to ask him what his federal tax bill would be. Levi explained how the federal tax system allows them to exclude that gain. If a taxpayer is married filing joint, he and his spouse can exclude up to $500,000 (it would only be $250,000 if John were single) of the gain on a house that was their principal residence for at least 2 out of the last 5 years.

This exclusion can only be taken once every 2 years. Levi also mentioned that there are various exceptions to the rules which could help taxpayers exclude at least part of the gain even if they do not meet the normal requirements but have special conditions. Special conditions include the death of a spouse, a health-related move, a work-related move, and others. John and Rose met all the requirements, and therefore they gained $100,000 without needing to pay a dime in federal taxes on the gain.

“Levi explained to them that they could exclude the gain from the sale of the lot as part of the transaction of selling their home, if they sold the lot within two years of selling the home, and if the total gain did not exceed $500,000”.

Let’s change up the principal residence scenario. Suppose that when John purchased the home, he also purchased a vacant lot on a separate deed next to it. John and Rose planted grass on the vacant lot, and treated it as part of their home’s yard. Levi explained to them that they could exclude the gain from the sale of the lot as part of the transaction of selling their home, if they sold the lot within two years of selling the home, and if the total gain did not exceed $500,000.

Final Thoughts

As you can read, taxes on house sales really varies. If you want to sell a house, talk with a tax expert before finalizing the sale. The tax expert may be able to help you find a benefit, such as waiting a little longer until a time deadline passes. Furthermore, if you will owe taxes, then the tax expert may be able to estimate roughly your tax liability so you can stow away some money to pay what is owed.

 

Preface: Do you own a house whose value has increased since you bought it? If so, you might be curious about the tax consequences if you sell it. The taxes for selling a house vary depending on the scenario. This article explores some of the tax consequences when selling houses.

Tax Planning on Residential Real Estate Transactions (Segment I)

Credit: Jacob M. Dietz, CPA

Buy and Sell Same Year

Assume John Georges had some money to invest, and he purchased a house at the advice of his father. He bought a $200,000 brick rancher in June 2018. John heard real estate prices were climbing rapidly in his area, so he decided to wait for a buyer instead of renting it out.

“John therefore sold it to them at a $25,000 gain. The income would be a short-term capital gain since John owned it for less than a year”.

In August 2018, John’s realtor that helped him buy the house called him and said another buyer desperately wanted to buy the house, and they were willing to pay John’s asking price. John therefore sold it to them at a $25,000 gain. The income would be a short-term capital gain since John owned it for less than a year. Short-term capital gains are taxed at ordinary tax rates. Note that only the gain (sale price less purchase price less other adjustments such as selling costs) is taxable, not the entire sales price.

Buy and Sell plus other Goods

This scenario is the same as the first scenario, except when John sold the brick rancher, he received an additional $25,000 for items left in the house by the previous seller. These items included furniture for all the rooms. The additional 25,000 increased his income to $50,000, taxed at ordinary rates.

Buy and Sell after more than a Year

In this scenario, the facts are the same as in scenario 1 except for the sale date. John owned the house without receiving any offers for nearly a year.

“Levi explained to John the difference between short-term and long-term capital gains. If John sells a house he owned for a year or less, it is a short-term capital gain”.

Shortly before a year ended, a realtor contacted John with an offer. John was pleased with the price, but he called his accountant, Levi, before deciding. Levi explained to John the difference between short-term and long-term capital gains. If John sells a house he owned for a year or less, it is a short-term capital gain. Levi explained that short-term capital gains are taxed at ordinary rates. On the other hand, houses owned over a year receive long-term capital gain treatment.

“Levi recommended that John go ahead and accept the offer, which would bring John a $25,000 profit, but Levi also advised that John wait to settle on the house until more than a year after the purchase date”.

The tax rate varies for long-term capital gains, but it is lower than ordinary income tax rates. Levi recommended that John go ahead and accept the offer, which would bring John a $25,000 profit, but Levi also advised that John wait to settle on the house until more than a year after the purchase date. By waiting a few weeks to close, John benefitted from the lower long-term capital gain rates.

Conclusion of Segment I.

Preface: “We must go beyond textbooks, go out into the bypaths and untrodden depths of the wilderness and travel and explore and tell the world the glories of our journey.” — John Hope Franklin

“I vividly remember a conversation I had many years ago in 1974, which marked a turning point in my leadership journey. I was sitting at a Holiday Inn with my friend, Kurt Campmeyer, when he asked me if I had a personal growth plan. I didn’t. In fact, I didn’t even know you were supposed to have one.” — John C. Maxwell

Navigate Business with a Good to Great Balance Sheet (Segment II)

Credit: Jacob M. Dietz, CPA

If you want more accurate financial numbers, take the time to adjust your businesses balance sheet accurately. Trying to navigate a course for your business using inaccurate financial reports can be like trying to navigate with a 50-year-old atlas. You may miss your intended destination on the journey. Alternatively, you might reach your destination, but it may take you on a long route. Using accurate financials can help you reach your goals on your journey.

Liabilities

Liabilities are what the company owes, and they should be examined as well.

If your company has Accounts Payable, review an aging schedule. Does your accounting system indicate that you owe invoices that you really do not owe? If so, clean them up. Why would it show that you owe money that you don’t owe? One scenario could be that your company did owe that amount once, but that it was entered twice. Your company paid one entry, but the other entry still lingers in your books as a payable. If this scenario happened to your company, then the lingering entry should be fixed.

If you company purchases with credit cards, are the credit cards reconciled? Business expenses purchased on a credit card should be recorded in the accounting system. Verifying the ending balance could detect if some credit card purchases were not entered that should have been.

If your company has any debt, either to a bank, an individual, or anything else, verify if the ending balance is accurate. If you receive statements, the balance sheet can be compared to that. If it is a loan to a person, you may want to compare to an amortization schedule that you both agreed to in the beginning of the loan.

As with assets, consider if there are any liabilities not on the books that should be recorded. For example, did someone loan the company money but it’s not recorded in the accounting system? If your company uses the accrual system of accounting, consider if there are any accruals, such as for payroll, that should be entered or adjusted.

Equity

Equity shows the ownership interest in a company. Does the equity on the balance tie to the tax return, or the accounting records that were used to prepare the tax return? If it doesn’t, then you might overpay in taxes. How could this happen? Assume that your accounting records show an invoice of 5,000 on December 31 that is included in income. Your accountant receives your accounting records and prepares a tax return reporting the $5,000 from that invoice as income. Later, for some reason, the date of the invoice is changed to January 1.   If your accountant later looks at the profit and loss for the next year, the $5,000 will show up again. Thus, the $5,000 could get taxed twice. Moving the invoice from December to January will change equity, however, so reviewing total equity can help detect this change.

If the company has multiple partners, then consider breaking down equity by partner. If equity is broken down by partner, then generally it should tie to the K-1s in the tax filing. The accounting software likely will not allocate the equity for you properly, so it may need to be done manually. For example, the earnings from the previous year may get dumped into a single account by the accounting software. Your accountant should be able to help you allocate the equity among the partners.

Navigate with a Good Map

This article discusses clean books, but it takes more time to adjust books accurately than it does to read this article. The benefits of accurate accounting records, however, can be great.

If your balance sheet is as inaccurate as a 50-year old map, start adjusting it accurately right up to the FICA taxes. Systematically go through the balances and review if they are accurate and if beginning numbers tie to the prior year return. Although an accurate balance sheet doesn’t guarantee an accurate profit and loss statement or statement of cash flows, it puts you in a better position to prepare and accurate profit and loss statement and statement of cash flows. Travel with modern maps, and navigate your business with an accurate balance sheet.